With dozens of competing lenders and
mortgages to choose from, you may think that today's home loan
market is terribly confusing. It really isn't though if you know the
basic facts about financing a house. That's what this brochure is
designed to give you. Let's start with the questions that are
probably uppermost in your mind.
How Large A Mortgage Can I Get?
That depends upon your income and
the cost of your new house. Lenders use certain guidelines to
determine the mortgage amount that they will lend any one home
buyer. The two guidelines used are housing expenses and long term
debt. Lenders generally say that housing expenses (including
mortgage payments, insurance, taxes and special assessments) should
not exceed 25 percent to 28 percent of the homeowner's gross monthly
income. For Federal Housing Administration (FHA) loans, this
figure is not to exceed 29 percent of the home buyer's gross monthly
income. With loan guaranteed by the Department of Veteran's
Affairs (VA), lenders measure prospective home buyers with
"Residual Income," or the monthly income minus expenses.
The remainder is t hen measured against geographical and
family size data to qualify the borrower.
-
FHA Loans
- Housing expenses = 29% of
gross monthly income
- Housing Expenses Plus
Long-Term Debt = 41% of gross monthly income
-
VA Loans
- Housing Expenses Plus
Long-Term Debt = 41% of gross monthly income
- Residual Income = Varies by
location and family size
-
Conventional Loans
- Housing Expenses = 25% -
28% of gross monthly income
- Housing Expenses Plus
Long-Term Debt = 33% - 36% of gross monthly income
Lenders usually define long-term
debt as monthly expenses extending more than 10 months into the
future. These expenses should not exceed 33 percent to 36 percent of
the homeowner's gross monthly income. VA and FHA mortgage lenders
define long- term debt as monthly income. Your lender will work out
these figures for you when you sit down to discuss the mortgage you
want.
What Types Of Loans Are Available
Although you may see many different
types advertised, they all belong to just two families: those
mortgages that carry fixed interest rates, and those whose rates
change during the course of the loan on a periodic schedule mutually
agreed upon by you and your lender. This page does, however, discuss
some new loans who are really "cousins" to each family-convertible
mortgages.
Fixed Rate Mortgages
You are probably familiar with a
fixed-rate mortgage. Your parents more than likely had one, as did
their patent before them. The major advantage of fixed rate
mortgages is that they present predictable housing costs for the
life of the loan. Some fixed-rate mortgages you will probably hear
about are:
- 30-year fixed-rate mortgages
- 15-year fixed-rate mortgages
- Bi-weekly mortgages
- "Convertible" mortgages
When people thought of a mortgage 10
to 50 years ago, they thought of a 30-year fixed-rate mortgage. This
traditional favorite is not the only choice nowadays because
volatile financial times created a whole new range of selections. However, the 30-year fixed-rate mortgage may still be the best
mortgage for your circumstances. It offers the lowest monthly
payments of fixed-rate loans, while providing for a never- changing
monthly payment schedule. Some lenders offers 25,20, and even
40-year term mortgages as well. But remember, the longer the
term of the loan, the more total interest you will pay.
The 15-year fixed-rate mortgage
allows homeowners to own their homes free and clear in half the time
and for less than half the total interest costs of the traditional
30-year loan. The loan's term is shortened by the 10 percent to 15
percent higher monthly payments. Some home buyers prefer this
mortgage because it allows them to own their home before their
children start college. Others prefer it because they will own
their home free and clear before retirement and probable
declines in income.
The major disadvantages or the
15-year fixed-rate mortgage are the sometimes higher monthly
payments. But if saving on total interest costs and cutting the to
free and clear ownership are important to you, the 15-year
fixed-rate mortgage is a good option. The bi-weekly mortgage
shortens the loan term to 18 to 19 years by requiring a payment for
half the monthly amount every two weeks. The bi-weekly payments
increase the annual amount paid by about 8 percent and in effect pay
13 monthly payments(26 bi-weekly payments) per year. The shortened
loan term decreases the total interest costs substantially. The
interest costs for the bi-weekly mortgage are decreased even
further, however, by the application of each payment to the
principal upon which the interest is calculated every 14 days. By
nibbling away at the principal faster, the homeowner saves
additional interest. Remember, however, that you trade lower total
interest costs for fewer mortgage interest deductions on your
federal income tax. Your ability to qualify for this type of loan is
based on a 30-year term, and most lenders who offer this mortgage
will allow the home buyer to convert to a more traditional 30-year
loan without penalty. Availability is limited on this mortgage, but
it can be worth looking for.
Mortgages That Change
Some newer mortgages afford home
buyers some the best qualities of the fixed-rate and adjustable rate
mortgages. One new type of loan, often called a Two-Step, Super
Seven, or Premier Mortgage, gives homeowners the
predictability of a fixed- rate and adjustable rate mortgage for a
certain time, most often seven or 10 years, and then the interest
rate is adjusted to fit market conditions at that time. The main
advantage associated with this type of loan is that home buyers
often get a slightly lower than market rate to begin with. The main
disadvantage is that they may see their interest rate go up by as
much as six percentage points at the end of the seven-year period.
The lender may also reserve the option to call the loan
due with 30 days notice at that time, making this loan
similar to a balloon mortgage in some cases.
Lenders offer this type of loan in
part because research indicates that many home buyers remain in the
home for seven to 10 years before moving. For this type of
home buyer, the Two-Step or Super Seven loan present an
excellent way of getting a fixed- rate loan at a better
than market price for a fixed-rate loan at a better than
market price for a fixed period of time.
Another type of mortgage that is
becoming popular is called a Lender Buydown, where the home
buyer gets an initially discounted rate and gradually increases to
an agreed-upon fixed rate over a matter of three years. For example:
When the market rate is 10 percent, the fixed rate for the mortgage
is set at about 10.5 percent, but the home buyer makes monthly
payments based on a first year rate of 8.5 percent. The second year
the rate goes up to 9.5 percent, and for the third year through the
remaining life of the loan, the rate is calculated at 10.5 percent. A second type of lender buy-down, called a
Compressed Buydown, works the same way, but with
the interest rate changing every six months instead of
on a yearly basis.
The Lender
Buydown gives consumers the advantage of lower initial
monthly payments for the first two years of the loan
when extra money may be needed for furnishings and,
secondly, the advantage of knowing that, although the
interest rate does change during the first three years
of the loan, the interest is fixed from the third year
on.
Convertible
mortgages offer today's home buyer the option to change
the loan's interest rate after some period of time or
some specified movement in interest rates.
Convertible fixed-rate mortgages are
often referred to as the Reduction Option Loan (ROLE) or, in
some locations, the Reducing Interest Loan (RIL), or Mortgage
(RIM). This new type of loan offers homeowners the option of
getting a loan that , under the right conditions, can be adjusted to
a lower interest rate with a payment of $100 or $200 or so and a
small loan amount-based fee, sometimes as little as one-fourth of a
percentage point. These conditions usually are a prescribed
movement in rates-typically two percent below the
initial- during a set time limit-between months 13 and
59, for example.
On a 30-year fixed-rate mortgage
with a reduction option, the home buyer pays an extra one-fourth to
three-eighths of a percentage point in the interest rate on the
mortgage plus a quarter to three-eighths of 1 percent of the loan
amount (points) at the time of closing. This allows the
homeowners to adjust the interest rate on the loan
without having to go through a refinancing, which could
cost up to 5 percent or 6 percent of the loan amount, if
the rates are right during the prescribed time limit.
On an $80,000 loan, this means that
you could reduce the interest rate on your loan from, say, 10.5
percent to 8.5 percent, and take advantage of the low rates for the
rest of the loan term for $150 instead of up to $4,800 , if the
rates dropped to that point during your "window of opportunity" -
months 13 through 59. Some homeowners may find the ROL a good
"insurance policy" against the high costs of refinancing. Others may
want the flexibility that refinancing offers - namely the ability to
draw on built-up equity- that is not available with ROLs. The
decision is up to you.
Convertible Adjustable Rate
Mortgages (ARMs) are another new loan
product on today's market. It worked like any other ARM, but
it offers homeowners a distinct advantage-it allows them
to turn their ARM into a fixed-rate mortgage after a set
period (usually during the second through fifth years of
the loan).
A new product developed by the
Federal National Mortgage Association (Fannie
Mae), which buys mortgages from lenders, allows the
homeowner to convert an ARM to either a 15 or 30 year fixed-rate
mortgage for a fee of 1 percent of the original loan plus $250 , as
compared to the 3 percent to 6 percent costs of refinancing. Say,
for instance, that you got your convertible ARM at an initial
interest rate of 10.0 percent, and after a year or so, rates had
dropped to 8.0 percent. For the smaller conversion fee, you could
adjust your mortgage to either a 15 or 30 year fixed-rate loan at a
new rate that would be about one-half percent higher than the going
market rate, or 8.5 percent. There are other variations on this loan
available from lenders across the country. Home buyers who want the
low initial rate of an ARM, and the option and peace of mind of a
fixed mortgage should rates drop, can now have it both ways.
Adjustable Rate Mortgages
Adjustable Rate Mortgages (ARMs)
have become on of the most popular and effective tools for helping
some prospective home buyers achieve their dream of home ownership.
Developed during a time of high interest rates that kept
many people out of the housing market, the ARM offers
lower initial rates by sharing the future risk of higher
rates between borrower and lender.
There are several things to compare
when looking at different ARM products. If you are thinking about
getting an adjustable rate mortgage, make sure you inform yourself
on how they adjust and what it is based on.
One of the last things to use for a
good comparison is the start rate. A low start rate is always nice
to have. Just make sure you are looking at the whole picture because
that nice low rate won’t stay there for very long. They usually
adjust either every 6 months or every year.
ARMs can be an excellent choice of
financing under certain conditions, such as rising income
expectations, high interest rates, and short-term home ownership. But because payments and interest rates can increase, either
steadily or irregularly, home buyers considering this kind of
mortgage need to have the income to keep up with all possible rate
and/or payment changes. Each ARM has four basic components:
-
Initial interest rate,
which is typically one to three percentage points lower than
that of most fixed-rate mortgages. Lower interest rates also
make ARMs somewhat easier to qualify for. The initial
interest rate is tied to certain economic indicators
that dictate in part what the monthly payments will
be.
-
Adjustment interval,
at the time between changes in the interest rate
and/or monthly payment will be.
-
Index,
against which lenders measure the difference between what they
are making on their investment in the mortgage and what they
could be making on other types of investments. The most
popular index is based on the rate of return on a
one- year Treasury bill (also called T-bill).
-
Margin,
or the additional amount the lender adds to the index to
establish the adjusted interest rate on an ARM. The margin
is usually 1.5 percent to 2.5 percent.
It is the
index plus the margin that will determine what the
interest rate will eventually be.
The Index
An Arm’s interest rate goes up and
down according to a nationally published index. The lender has no
control over the index and cannot arbitrarily adjust your rate. Your
rate is determined by the index.
The index is what the lender uses as
a reference for what it might cost to take in money that it can then
lend. Take the CD Index as an example. If a lender is
currently paying 5% to depositors for Certificates of
Deposit it must then make up that cost when it takes
those funds and lends them out.
The index on an adjustable rate
mortgage will change during the time that you have the loan. So
whatever the index is at when you initially get your loan you can be
sure that it will change during the time you have your loan. An
index can go up or down depending on the current market conditions. There are several different indexes and they are tied to different
market indicators that will change differently.
Treasury Bills
This arm index is officially called
"The weekly average yield on U.S. Treasury securities adjusted to a
constant maturity of 1 year." It is based on the interest rate that
the government pays on some of its debt. This index is used on the
majority of ARM loans. The Treasury Bill index tends to be fast
moving, which means that when market conditions in interest rates
change, they will react to that change very quickly. This can
be a good thing if rates are going down, and not so good
if rates are going up.
Twelve Month Moving Average
This index is the "Twelve month
moving average of the average monthly yield on U.S. Treasury
securities (adjusted to a constant maturity of one year.)" Like the
Treasury bill index, this index is based on U.S. Treasury
securities. Because the index calculation is an average of an
average, it is less volatile.
Certificates of Deposit (CD Index)
This index is "The weekly average of
secondary market interest rates on 6-month negotiable certificates
of deposit." They are interest bearing bank investments that will
lock your savings rate in for a specific period of time. The longer
the time you lock your deposit in, the higher the rate being paid on
the certificate. ARM loans tied to this index are usually tied to
the average interest rate banks are paying on 6-month CD’s. This
index is also quick moving, but banks typically will adjust interest
rates more slowly when rates are going up in order to avoid paying
depositors a higher interest rate. Since this index is tied to bank
CD’s you can expect this index to adjust a bit more slowly on rising
interest rates. They also tend to come down quickly when rates
decline because banks do not want to pay higher interest
unnecessarily.
The index is also known as COFI
(pronounced just like a cup of coffee). It is published monthly by
the Federal Home Loan Bank Board. The index shows the monthly
weighted average cost of savings, borrowings, and advances, for
member banks in California, Arizona, and Nevada (the 11th. District). Because COFI is a moving average of rates that bankers
have paid depositors in recent months it tends to be more stable. This means that the index will increase more slowly when rates are
going up. It will also decrease more slowly when rates are
going down.
Libor
This is the London Interbank Offered
Rate index. It is an average of the interest rates that major
international banks charge each other to borrow U.S. dollars in the
London money market. These rates are available in 1, 3, 6, and 12
month terms. The index used, and the source of the index will vary
by lender. Common sources are the Wall Street Journal and Fannie
Mae. The interest rate on many LIBOR indexed ARM loans are adjusted
every 6 months. Libor also changes quite rapidly to
adjustments in interest rates.
Margins
The margin is the markup that
lenders charge on the money they are lending. It is usually
somewhere around 2.50%. The margin does not change during the life
of the loan. If your lender offers you various margins, you should
consider the lower margin since it will have an impact on how much
your rate will increase during the loan term. It is the index plus
the margin that gives you the fully indexed rate. This is the rate
that your loan should actually be at according to current market
conditions. If you have a low start rate, you can be sure it will
adjust to the maximum amount it is allowed to at every adjustment
period until it reaches the fully indexed rate. Remember though,
that the fully indexed rate will change because the index changes,
even though the margin does not.
Adjustments
It is important to find out how
often the particular ARM loan you are looking at will adjust. Adjustments are usually every 6 or 12 months. If your loan adjusts
monthly his should alert you that this loan might have negative
amortization. Negative Amortization loans will be discussed
later in this chapter.
The lender must inform you before
your interest rate is about to adjust. There are usually limits
built into the loan as to how much the rate can increase at any one
time. These limits are known as periodic rate caps. When
shopping for an ARM loan always find out how often the
loan will adjust, and what the interest rate caps are.
Periodic Adjustable Rate Cap
There are two types of rate caps. There is the periodic adjustment cap and the lifetime cap. The
periodic adjustable rate cap limits the maximum rate change, up or
down, allowed for each adjustment. If your ARM adjusts every 6
months, the periodic cap is usually 1% (one percentage point of your
loan amount). If your ARM adjusts every 12 months the periodic
cap is usually 2%.
Lifetime Cap
You
should never take an ARM without a lifetime cap.
This cap limits the maximum amount that the interest
rate can adjust over the life of the loan. ARM loans usually have a
lifetime cap of 5 to 6 % above the start rate of the loan. When
deciding on an ARM loan always figure your payment at the maximum
rate. This way you will know in advance the very worst-case
interest rate for your loan.
Negative Amortization Loans
Some loans have caps for the amount
of your monthly payment. At first this may appear to be beneficial
because even though your interest rate might be at the fully indexed
level, your payment will only adjust a certain percentage each year. This is a negative amortized loan. With this type of loan you may
get a low starting interest rate for the first 3 months and then the
loan will go to the fully indexed rate. Even though the rate has
adjusted to the fully indexed rate, your monthly payment will
increase only once per year. When it does increase, it can only
increase by a certain percentage from what it was. This is the
payment cap.
When you have a loan where the
payment does not adjust to meet the interest rate being charged on
the loan, you are not paying off all of the interest each
month. What then occurs is the unpaid interest is added on to the
balance of your loan. You are not fully paying off your
mortgage over the 30 year period as you would in a fully
amortized loan over 30 years.
This type of loan does have some
benefits. It is usually easier to qualify for and can help out
buyers who are having problems qualifying at the standard 30 year
fixed rate. It also usually offers the borrower an option on how
they wish to pay the loan off each month. They can pay the fully
amortized payment, and not allow the loan to go into negative
amortization. They can pay the full interest only payment, which
does not pay the mortgage down but also does not add to the mortgage
balance. They can pay the fully amortized payment for a 15-year loan
and pay the balance in full in 15 years. They can also pay the
smallest payment allowed which is at the payment cap and allows the
loan balance to increase. If your negative amortization loan has
this feature, you can usually choose each month which payment option
you want to take. This can often make this type of loan very
flexible. It is important to remember though, that if you are the
type of borrower who will more then likely always pay the minimum
due each month, this type of loan is probably not for you.
Before you make your final decision
on an ARM loan you should ask yourself the following questions:
1. Have you budgeted for
higher mortgage payments? Can you afford to pay the
increases in your mortgage and still be able to accomplish
your other financial goals?
2. Will you have at least 6
months worth of living expenses left over in an accessible
account after close of escrow? This will help to cover
rising mortgage payments.
3. Do you know that you can
pay the highest payment your arm loan may reach? This is the
payment if the interest rate on the loan were to reach the
maximum rate possible. Your lender should be able to tell
you this payment.
4. If you are borrowing the
maximum amount allowable for the sales price of the house,
do you have a stable job and steady income? Do you expect
the size of your family to change in the near future? It is
important to budget for any possible life changes.
5. Will an increasing
mortgage payment create undo stress in your life? If you are
the type of individual that does not easily handle changes
such as this, an adjustable mortgage may not be a good
choice for you.
An adjustable rate mortgage
could very well save you money over a fixed rate mortgage on the
life of your loan. Just consider if you are financially and
emotionally secure enough to handle the maximum possible
payments over the life of the loan.
Another thing you need to
consider when choosing the type of loan that is right for you is
the length of time you expect to be living in the home. If you
don’t plan on staying there for a long period of time, (usually
less then 5 years) an ARM loan might be a good idea. For the
first 2 –3 years of an ARM loan you can usually save money over
the prevailing 30 year fixed rate.
If you expect to hold on to your
home for a longer period of time, a fixed rate loan can be the
best way to go.
In addition to the four basic
components, an ARM usually contains certain consumer safeguards such
as interest rate caps, which limit the amount that the interest rate
applied to the payments may move. This prevents the amount of
interest the consumer pays from rising higher than perhaps the
homeowner can afford. For instance, a typical ARM would have a two
percentage point cap over the life of the loan. That means
that a loan with an initial interest rate of 9.75
percent would be able to go no higher than 14.75 percent
over the life of the loan, and it would be able to move
no more than two percentage points per year.
Another safeguard found on some ARMs
are monthly payment caps that limit the amount homeowners need to
increase their payments at adjustment time. Monthly payment
caps can, however, sometimes prevent the monthly
payments from increasing enough to keep up with the rise
in the interest rate, causing negative
amortization-resulting in higher or more payments for
the homeowner later on.
Other options you should ask about
when shopping for an ARM are:
-
Assumability,
or whether you may transfer the mortgage to a new home buyer,
usually with the same terms if the new home buyer qualifies for
the loan. ARMs are almost always assumable.
-
Convertibility
allows the borrower to change an ARM to a fixed-rate
mortgage, usually at the end of some predetermined
period, locking in a lower interest rate.
An Option For Older Homeowners
A relative newcomer in the mortgage
market is a Reverse Annuity Mortgage (RAM). For older
Americans, especially retirees living on fixed incomes, the equity
in their paid-for or almost-paid-for home represents a large but
liquid asset. The RAM is designed to help supplement those
homeowners' income.
The lender who will issue a RAM
appraises the property and makes the loan based on a percentage of
its current value. The homeowner retains ownership, and the property
secures the loan. The lender then pays an annuity to the
borrower, usually on a monthly basis, up to an amount
equal to the equity they have in the home.
The advantage of such a loan for
older Americans is that of receiving a monthly tax-free income. Under one plan, this income is available for life or until the house
is sold at the homeowner moves. The schedule of payments depends on
the value of the home and the ages of the owners. There are risks
involved, however. If the homeowner wants to move and buy a new
house, there may not be enough equity in the home to permit such a
plan. Or the lender may consider only the current market value of
the home rather than any future appreciation when deciding on the
monthly payments.
FHA/VA Mortgages
The Federal Housing Administration
(FHA) and the Veterans Administration (VA) offer a wide range of
mortgage choices that may appeal to you. These include 30 and 15
year fixed- rate mortgages, as well as ARMs. Insured by these
government agencies, the loans feature low or no down payment terms
and are often assumable by future purchasers. VA loans are
restricted to individuals qualified by military service or other
entitlements, but FHA - insured loans are open to all qualified home
purchasers. Note that there are limits to handle moderate-priced
homes anywhere in the country. Talk to your lender about FHA/VA
possibilities.
Creative Financing or Seller-Assisted Mortgages
This type of financing became
popular when interest rates went to very high levels in the early
1980s. Seller-assisted creative financing usually means the
seller of the home helps with the financing by
underwriting all or part of the loan.
The advantage of this type of
arrangement is that the mortgage usually carries a lower interest
rate with lower monthly payments. The disadvantage is that the
previous homeowner, not an institution, may hold the deed of trust. If the loan terms call for certain payment schedules, the buyer may
have to seek new financing. Many home buyers in recent years
have found "creative financing" deals to be fraught with
problems and useful only as short-term alternatives to
mortgages from traditional lenders.
One type of
mortgage you are apt to run into with seller financing
is the balloon payment mortgage. Balloons, as they are known, are usually offered as short-term
fixed-rate loans. The balloon payment mortgage gets its name from
the payment schedule, which involves smaller payments for a certain
period of time and one large payment for the entire amount of the
outstanding principal. They have terms of 3, 5, and sometimes 15
years, though payments are usually calculated as though it were a 30
year loan. Sometimes a balloon will be offered as a second mortgage
where you also assume the homeowner's first mortgage . The major
disadvantage with a balloon payment loan is that it may be difficult
to save up the money to make the final large payment (often the
entire amount of the principal) while paying interest on the loan. Some lenders guarantee refinancing, though the interest rate is
usually adjusted when the principal comes due. If you cannot
refinance, you may have to the property if you cannot meet the large
payment. Balloons are an advantage if you plan on living in an
appreciating house for a short period of time and want to pay less
while you live there.
How Do You Shop Most Effectively For A Mortgage?
There are several ways. First, talk
with your real estate agent or broker. Real estate professionals are
normally in the best position to learn about financing opportunities
in the marketplace. Lenders regularly call agents to alert them to
financing packages. And, of course, agents are highly motivated to
obtain financing for their buyers. Without a suitable loan,
the sale can't proceed, and agents won't get their sales
commission on the house.
Second, look for rate surveys
published by your local newspaper. Many American papers now include
brief tables on interest rates and mortgage availability in their
real estate or business section. They can help guide you to
sources you have not thought about.
Third, look in the Yellow Pages
under "Mortgages," and shop for quotes by telephone.
Call five to 10 different lenders for rates and terms on
fixed and adjustable loans.
Finally, if your area is covered by
one of the many commercial computerized mortgage shopping
services, give it a try. You may find, however, that the
computer services have only a selection of local lenders on their
listings.
How Do We Evaluate Different Loans?
One important method is by bearing
in mind that mortgage packages consist of more than interest rates.
They consist of a quoted rate, plus discount points
(pre-paid interest assessed by the lender at settlement,
or the meeting when the property legally changes hands)
and other fees, plus a full range of terms including
adjustable versus fixed-rates, low down payment versus
high down payment, the presence or absence of prepayment
penalties, and many other features noted earlier in this
brochure.
\Comparing Rates
If you start calling around to
different mortgage lenders you might get one lender quoting you an
interest rate of 7% for a 30 year fixed rate, while another lender
quotes you a rate of 6.75%. If you automatically jump at the
lower rate of the two, you could end up costing yourself
a lot more money.
Remember that an interest rate quote
always goes along with points to be paid on the loan. A lender can
quote you varying interest rates, and almost always the lower the
rate the higher the points.
Points are charged by the lender as
a way to pay for the expense and work associated with obtaining you
a mortgage loan. When comparing rates it is always important to also
calculate the points involved.
One way to do this is to compare
what the payment would be for the 7% loan to what it would be for
the 6.75% loan. Subtract the lower payment from the higher one to
get the monthly difference in payment. Now you know how much
you would save each month of you took the lower interest
rate.
The next thing you want to do is
compare the points. A point is 1% of the loan amount. So if your
loan is $100,000 one point would be $1,000. Let’s say the interest
rate of 7% is for a one point loan or $1,000. Maybe the points for
the 6.75% loan are 1.50% or $1500. You will then be paying $500 more
in points for the lower rate. If the difference in payment is $33.23
per month, how long will it take to make up for paying the extra
$500? If you divide $500 (the difference in the cost of the points)
by $33.23 (the monthly savings) you will get 15.05. It will take 15
months to break even. After 15 months you will actually be saving
money. If you plan on keeping this house for a long period of time
and staying in this mortgage you will be saving a lot of money over
the life of the loan. After the first 15 months you will save
$398.76 per year if you take the lower interest rate.
Another thing to consider when
deciding on rates and points for your loan is the tax benefits. Points paid on the purchase of a home are tax deductible. You can
claim them as an itemized expense on your schedule A of IRS form
1040.
If you have the cash, and are
planning to live in the home for a long period of time, you will
want the lowest interest rate you can get. Paying the extra
points required to get the lower interest rate can be a
good idea if you work out the cost and the months of
lower payments required to make this cost up.
If you are strapped for cash and can
just come up with the down payment and minimal closing costs there
won’t be a lot of money to pay points. If you plan on living in the
home a short period of time, paying less in closing costs and a
little more each month makes good sense.
If someone quotes you a no point
loan don’t automatically think you are getting a deal. This is also
true of a no point – no fee loan, where you do not pay any fees at
all for the loan. Remember the rates/points tradeoff. You don’t get
something for nothing. A no point loan may make sense if you have
very little funds available for closing costs. You will also find
that homeowners who refinance over and over again like to have a no
point loan. This way they can refinance into another interest rate
whenever rates decline and not be concerned with the added expense
of paying points to do this. They still will not be receiving the
best rate available, but it can still work to their advantage if
they think rates will be going even lower and will want to refinance
again, or will not be staying in this home that much longer anyway.
One way to evaluate rates, however,
is by examining the Annual Percentage Rate (APR). The APR can
help you compare different types of mortgages. It indicates the
"effective rate of interest" paid per year. The figure includes
discount points and other charges and spreads them out over the life
of the loan.
By law the APR must always be
disclosed to you within three days after applying for a loan. The
APR is the effective interest rate for loans that are repaid over
their full term. The APR calculation assumes you will be keeping
your loan for its full term. However, most people sell or refinance
their loan within 6 to 12 years. If a $100,000 loan were repaid
after 6 years rather then the usual 30, the effective interest rate
would be 8.66%; not the 8.32% APR you would be quoted. A fairly
accurate way to estimate the APR for comparison is:
Effective interest rate = quoted
rate + (number of points / 6) If you plan to stay only 4 to 6 years,
divide the points by 4. If you plan to stay for 1 to 3 years, divide
the points by the number of years.
While the APR provides you with a
common point for comparison, look at the whole product before
deciding which mortgage to get. Pick the one with the rate, payment
schedule and other terms that suit your situation best.
A good way to compare costs when
shopping for loans is to ask lenders to quote you a rate based on
the same points (a one-point loan is good for comparison). That way
you can generally see which lender has the better rate. Don’t forget
however, to compare the APR also. Just in case the lender with the
better rate/point quote isn’t adding on a whole lot of additional
fees. Always ask a lender whose loan you are considering to provide
you with an estimated breakdown of closing costs. That way you
can compare more accurately.
Terms You Should Know
-
Acceleration Clause
- If
you miss a monthly payment, an acceleration
clause allows the lender to speed up the rate at
which your loan comes due or even to demand
immediate payment of the entire outstanding
balance of the loan.
-
Assumability
-
Assuming a mortgage is simply taking the loan
over from the holder (seller) and becoming
liable for the repayment.
-
Buydown
- The Buydown mortgage is one
where the seller and/or the home builder subsidizes the
mortgage by lowering the interest rate during the first few
years of the loan. While the lower initial payment and
interest rate make this kind of loan easier to
qualify, the payments may increase when the
subsidy expires.
-
Closing Costs/Settlement
Costs/Escrow
- Closing costs ate the costs
associated with settlement, the meeting where the buyer and
seller (or their agents) sit down to fill out the papers and
make the exchanges that allow the property to legally change
hands. Closing costs include appraisal fees, title
search and insurance, survey, tax adjustments,
deed recording fees, credit report and points,
among others.
-
Due-on Sale Clause
- A
clause or provision in a mortgage or deed of
trust that allows the lender to demand immediate
payment of the balance of the mortgage at the
time of sale.
-
Negative Amortization
- This occurs when your
monthly payments are not large enough to pay all the
interest due on the loan. This unpaid interest is added to
unpaid balance of the loan. The danger of negative
amortization is that the home buyer could end up
owing more than the original amount of the loan.
-
Private Mortgage
Insurance
- In the event that you do
not have a 20 percent down payment, lenders will allow a
smaller down payment-as low as 5 percent in some cases.
With the smaller down payment loans, however,
borrowers are usually required to carry private
mortgage insurance.
Private mortgage insurance
will require additional premium payment of 0.5 percent to
1.0 percent of your mortgage amount plus an additional
monthly fee depending on your loan's structure. On a
$75,000 house with a 10 percent down payment,
this would mean an initial premium payment of
$338 to $675 and an extra $15 to $20 a month.
$75,000 MORTGAGE
|
| |
30 Year
|
15-Year
|
Bi-Weekly
|
ARM
|
| |
Fixed-Rate
|
Fixed-Rate
|
Mortgage
|
at 7.5%
|
| |
at 10%
|
at 10%
|
at 10%
|
w/5% cap*
|
| Monthly Payment
|
$ 658
|
$ 806
|
$ 658
|
$ 524
|
| |
|
|
(329 X 2)
|
|
| Interest Cost
|
|
|
|
|
|
First Year
|
7,481
|
7,398
|
7,434
|
5,602
|
|
Fourth Year
|
7,336
|
6,606
|
7,061
|
6,188
|
| Mortgage Balance
|
|
|
|
|
|
First Year
|
74,583
|
72,726
|
74,476
|
74,309
|
|
Fourth Year
|
73,052
|
64,372
|
69,817
|
72,400
|
| Interest Cost/Life
|
161,942
|
70,062
|
104,331
|
132,566
|
|
Difference from 30 Year Fixed Rate
|
- $91,880
|
- $57,611
|
- $29,376
|
* The interest on the ARM used
in this example increased 2 percent in the second year (payment
= $629), and decreased 1 percent in the third year (payment =
$577 for Years 3 through 30). This is a hypothetical situation. Not all ARMs will behave in this manner; some will increase (or
decrease) more slowly, some more rapidly. In each case, the
monthly payments, interest costs, and the amount you save will
differ. For more information about tailoring an ARM to fit
your particular circumstances, talk to your lender.
Should You Assume Someone Else’s Loan?
It is possible that the owner of
the home you are buying has an assumable mortgage. If that
is the case, there are some questions you need to
ask yourself before you assume someone else’s loan.
1. Is the assumable rate and
term better then the current loans available?
2. Will the lender charge
you an assumption fee? If so, how much?
3. What is the current
balance of the old loan? Is it large enough? Will I need
extra cash?
4. If the existing loan is
not large enough, will the seller take back a second
mortgage?
5. What would the rates and
cost be for a second mortgage from the seller and from
another lender?
6. Would the combined
payments of both a first and a second be less then if you
got a new first mortgage loan?